suggests the complementary nature of financial and nonfinancial data for cellular
stocks.
This chapter delves further into the notion that firm-specific nonfinancial
information can be fruitfully employed by investors in innovative, fast-changing,
science-based companies. Nonfinancial data may be particularly relevant in the
valuation of technology stocks where the productivity of investments in intangible
assets (such as patents) is a vital determinant of long-term success. Against this
backdrop, it becomes relevant to ask: Can scientific data that measure the quantity
and quality of inventive output be helpful in the valuation of technology stocks?
I. USEFULNESS OF NONFINANCIAL INFORMATION
Valuation effects of corporate research and development (R&D) expenditures
have long been used to provide useful, albeit indirect, evidence on the economic
consequences of the firm’s inventive and innovative activity. For example,
Hirschey and Weygandt (1985) were among the first to use market-value data to
establish the importance of R&D as an important source of intangible capital.
Hirschey and Spencer (1992) also show that R&D expenditures have consistently
large and positive influences on the market value of all size classes and document
that the strength of this relationship is inversely related to firm size. Like current
cash flow information, data on R&D spending appears to help investors form
appropriate expectations concerning the magnitude and variability of future cash
flows. This chapter details results reported by Hirschey, Richardson, and Scholz
(2001) on the economic consequences of invention and innovation as measured
by the valuation effects of patenting activity.
Accounting information gives a useful perspective on the economic value of
the firm that is historical, logical, and consistent. In contrast, stock market valua-
tions reflect a forward-looking viewpoint on the value of the firm’s future cash
flows. Differences between the historical accounting perspective and the stock
market’s forward-looking perspective are to be expected. The practical value of
accounting numbers is enhanced to the extent that such data can be profitably
used by investors as indicators of corporate health in their ongoing assessment of
the firm’s economic prospects. Unfortunately, Brown, Lo, and Lys (1999) docu-
ment a long-term decline in the relevance of financial statement information as an
important determinant of the market value of the firm. Controlling for size effects,
they find that there has been a dramatic decline in the value relevance of financial
statement information during the post-World War II period. This and related find-
ings have fed a growing concern among both academics and practitioners that
corporate financial statements have lost a significant portion of their relevance for
investors (Francis and Schipper, 1999). This concern has given rise to a number
of research and accounting policy initiatives with the common goal to improve
the practical relevance of financial reporting. Not only is value relevance a
significant practical matter in the United States, growing concern over the
158 CHAPTER 7 VALUATION EFFECTS OF PATENT QUALITY

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